Probably to live up to the glory of its geographical location, the economy of Sri Lanka has been going through several ebbs and flows for decades. Starting from years of civil war to battling the blow of the COVID-19 pandemic, the country has been standing firm in the face of all the adversities. But the question is, how far can prosperity be envisioned?
A Brief History of Sri Lanka’s Economic Challenges
Sri Lanka was reborn as a socialist country after gaining independence in 1948. However, it began to shift from a socialist orientation in 1977 under President J.R. Jayewardene. Since then, their economy has been privatised, deregulated and exposed to international competition.
In 2001, Sri Lanka was on the brink of financial collapse, burdened by a staggering debt surging to 101% of its GDP. Concurrently, the nation’s economy suffered a significant setback, experiencing a negative GDP growth rate of 1.4%, marking its first contraction since gaining independence.
Between 2002 and 2004, a fleeting ray of optimism emerged as Sri Lanka embarked on a peace process with the Liberation Tigers of Tamil Eelam (LTTE), characterised by ceasefire agreements and peace negotiations. During this period, Sri Lanka’s economy experienced some positive developments, including lower interest rates, a resurgence in domestic demand, a notable increase in tourist arrivals, a revitalised stock exchange, and heightened foreign direct investment (FDI). This economic upturn facilitated a gradual recovery, with 2002 witnessing a 4% economic growth rate, primarily driven by robust growth in the service sector and a partial revival of the agricultural industry. FDI inflows in 2002 amounted to approximately $246 million.
However, the peace process ultimately proved fragile and transient as the civil war was resumed in 2005, perpetuating the strain on the country’s finances that resulted from the halt of privatisation efforts, the establishment of new state-owned enterprises and re-nationalisation of previously privatised industries, all under the leadership of the then president Mahinda Rajapaksa. This alteration of economic policies led to issues like overstaffing, reduced efficiency, financial losses, and revelations of fraud and nepotism within state-owned corporations. Furthermore, Sri Lanka faced international repercussions as the European Union revoked preferential trade tariffs due to alleged human rights violations, resulting in an annual loss of approximately 500 million USD. The heightened violence and lawlessness also prompted some donor nations to reduce their aid to Sri Lanka. Additionally, a surge in global petroleum prices and the economic fallout from the ongoing conflict resulted in inflation reaching a peak of 20%. A sharp increase in defence expenditures was also noticed.
Sri Lanka had a challenging economic scenario in the mid to late 2010s, marked by rising debt levels and political instability that culminated in a downgrade of its debt rating. Notably, Sri Lanka’s tax revenues, which had languished at a meagre 10% of GDP in 2014, suggestively the lowest in nearly two decades, showed a slight improvement to 12.3% in 2015. However, according to Bloomberg, Sri Lanka remained a high-risk destination for investors despite the efforts at reform.
In 2016, the government successfully lifted an EU ban on Sri Lankan fish products, substantially increasing fish exports to the EU. Additionally, improved human rights conditions in 2017 prompted the European Commission to propose restoring the GSP plus facility to Sri Lanka. Over the past decade, China emerged as a significant creditor to Sri Lanka, surpassing Japan and even the World Bank.
However, economic growth slowed considerably in 2018, dropping to 3.3% and declining to 2.3% in 2019. During this time, Sri Lanka’s nominal GDP stood at $84 billion, with a purchasing power parity (PPP) of $296.959 billion. The depreciation of the Sri Lankan rupee against the US dollar during this period exacerbated foreign debt burdens and dampened domestic consumption. Thus, the country’s economic growth, which had been robust from 2003 to 2012, began to dwindle, leading to its reclassification as a lower middle-income nation by the World Bank.
In 2021, Sri Lanka declared its worst economic crisis in 73 years, suspending most foreign debt repayments after resorting to money printing to support tax cuts. This marked a significant shift from its previously solid record of debt service.
The Present Scenario
As aftershocks of the COVID-19 pandemic, the main pillars of Sri Lanka’s economy—tourism, tea exports, apparel, agriculture, and overseas employment—were severely affected. The tourism industry was decimated, and remittances from overseas workers fell. Furthermore, import costs soared high owing to the Ukraine conflict. Triggered by an acute balance of payments crisis, the country preemptively defaulted on over 50 billion USD of foreign debt in April 2022, leading to a crippling economic contraction accompanied by soaring inflation, which officially peaked at 57%. All these resulted in severe food and medicine shortages, 13-hour-long load shedding, extraordinarily long queues at petrol pumps and increased poverty. Thus, dissatisfied with the country’s deteriorating economic conditions, irate Sri Lankans stormed the then president Gotabaya Rajapaksa’s mansion. Under such circumstances, Rajapaksa fled the country, and the then Prime Minister, Ranil Wickremesinghe, became the new president.
In the latter part of 2022, President Wickremesinghe’s administration initiated several vital measures to stabilise the economy. These included tightening monetary policy to combat inflation, raising taxes, removing subsidies on fuel and electricity, and launching a privatisation program for state-owned enterprises. Discussions with the International Monetary Fund (IMF) and bilateral creditors regarding debt restructuring gained momentum. Recent developments imply that Sri Lanka is on a path to economic recovery. Overseas remittances and tourism figures are on the rise, thanks to President Wickremesinghe’s negotiation of a $2.9 billion bailout from the IMF.
Even though Sri Lanka’s journey from the depths of an economic crisis to newfound stability is commendable., challenges persist. Negotiations on debt restructuring pose uncertainties, and daily wage earners, representing a significant portion of the population and facing the harshest blow, continue to face economic hardships. President Wickremesinghe’s strategic moves and commitment to reforms have been instrumental in turning the tide. However, the nation must remain vigilant in addressing persistent economic challenges and ensuring that recovery benefits reach all segments of society.
What 2023 is likely to await
The Asian Development Bank’s (ADB) April 2023 outlook forecasts a further economic contraction of 3% in 2023 before a gradual recovery begins in 2024. This contraction is attributed to ongoing debt restructuring challenges and balance of payments difficulties. To address these issues, Sri Lanka has approved the International Monetary Fund’s (IMF) Extended Fund Facility arrangement and reversed the tax cuts of 2019. Implementing these reforms is crucial for stabilising the economy.
The crisis has significantly impacted poverty, with the World Bank estimating that poverty rates could jump to 27.4% in 2023. To mitigate this, the government has initiated a direct cash transfer program to support approximately 2.3 million families. However, critics argue that more than the proposed amounts are needed, given the gravity of the crisis.
However, there have been some positive developments in the two most crucial economic sectors— a 30% increase in tourism revenues and a 76% surge in remittances—helping boost reserves and stabilise the currency. However, Sri Lanka still faces the challenge of restructuring a significant portion of its $56 billion foreign debt. This includes international sovereign bonds and bilateral credits primarily owed to China, Japan, and India.
Since the current issue is not a momentary liquidity shock that can be rectified with outside funding assistance and is the product of long-standing structural flaws that were exacerbated by a succession of exogenous shocks, Sri Lanka must prioritise stronger reforms, including those related to land, labour, and loss-making state enterprises, to secure its economic recovery beyond the short term. Additionally, market access through free-trade agreements and attracting genuine investors will be essential to revitalise the export-driven economy. As stated by Bhavani Fonseka at the Center for Policy Alternatives in Colombo, “What we see now is the most vulnerable communities struggling and still facing hardships in getting three meals a day. The socio-economic indices indicate that still the crisis is far from over and it’s a long path to recovery.”
On the Bright Side
On a positive note, Sri Lanka boasts several strengths in its economy. It is the world’s largest centre for solid and industrial tire manufacturing and has an apparel sector progressively moving up the value chain. Additionally, the country has witnessed growth in its services sector, particularly in ports and airports, capitalising on its newfound status as a shipping and aviation hub, with the Port of Colombo being the largest transhipment hub in South Asia. Sri Lanka has also seen the emergence of a competitive software and information technology sector that is open to global competition. The tourism industry is rapidly expanding, with accolades from Lonely Planet and Travel + Leisure naming it the best destination to visit in 2019 and the best island, respectively.
Despite the hurdles, Sri Lanka’s past achievements in reducing poverty and its commitment to long-term development goals provide hope. With unwavering commitment to reform, strengthened governance, and international support for debt restructuring, Sri Lanka may navigate its way out of this crisis and return to a path of sustainable and equitable growth. However, it is clear that addressing the root causes of the crisis and implementing structural reforms will be challenging yet necessary steps on the road to revival.